Bank of England Governor Mervyn King said policy makers are right to keep the key interest rate at a record low because weak growth in money and wages signal the current bout of above-target inflation will prove 'temporary'."Subdued rates of increase in average earnings, as w ell as remarkably -- some might say disturbingly -- low growth rates of broad m oney have provided strong signals that inflation will fall back in due course," he said in a speech in London on Wednesday.A rate increase "would have meant a weaker recovery, or even further falls in output" and "a risk of inflation falling well below the target in the medium term."
King said interest rates will have to rise to "more normal levels" from the current 0.50%, though the timing is "simply impossible" to know because of uncertainty on the pace of the economy’s rebalancing and the impact of inflation that’s more than twice the bank ’s 2.0% target. The governor, who will chair the first meeting of the new Financial Policy Committee on Thursday, also said banks must have "much higher levels " of capital to protect against potential losses.Lenders are continuing to impro ve balance sheets and reduce leverage, King said. A return in interest margins from "unprecedentedly high levels" will affect the speed at which policy ma kers raise interest rates, he said."The committee is watching extremely carefull y for any signs of a pickup in domestically generated inflation and it will take action as soon as it is appropriate to do so," King said. "When conditions in the banking sector return to something closer to normal, those spreads will contract and the rate at which that takes place will have an important influence on the speed at which bank rate will rise."
Some measures of money supply have shrun k even after the bank completed a £200bn bond-purchase program. M4, which t he central bank uses to assess the effectiveness of its asset purchases, fell 2.0% in the 3 months through April on an annualized basis.Data Tuesday showed th e pickup in inflation to 4.5% in May has NOT yet fed through to salaries. Wag e growth including bonuses weakened to 1.8% in the 3 months through April fro m 2.4% in Q1.The challenge for the MPC is weak growth and faster inflation at a time when the economy "is going through a major rebalancing of demand and output," which will take "several years to complete," King said.
A weaker pound was a "necessary precondi tion" for the economy to rebalance, according to King, who said policy makers hav e had to "look through" its effect on inflation. Sterling has dropped about 25% o n a trade-weighted basis since the start of 2007."We could have raised bank rat e significantly so that inflation today would be closer to the target," King said.But that would not have prevented the squeeze on living standards aris ing from higher oil and commodity prices and the measures necessary to reduce o ur twin deficits."
King also raised concern that the Europe an Commission may weaken capital and liquidity rules for banks agreed by globa l regulators under the Basel III accord. He said that putting in place adequa te resolution procedures had to go hand in hand with ensuring that lenders are sufficiently protected against future crises by holding an adequate level o f common equity. "A crucial part of the new Basel III framework is the recognition that only common equity is a truly loss-absorbing layer of capital," he said. "I am, therefore, concerned that the European Commission will propose a weakening of the Basel standards in that area."
King will present the findings of the FPC’s first meeting on June 24th, and said he will comment on where the panel, cr eated to oversee financial stability, sees risks increasing."The FPC will be both doing and learning," King said. In the wake of such a severe crisis, it is unlikely that excessive credit growth will be the major problem over the ne xt few years. Indeed, the present problem is the reverse."Lawmakers at the UK Parliament’s Treasury Select Committee are examining accountability at th e Bank of England and King today responded to comments by former policy makers on the extent of the powers he will have as chairman of the FPC.
King said interest rates will have to rise to "more normal levels" from the current 0.50%, though the timing is "simply impossible" to know because of uncertainty on the pace of the economy’s rebalancing and the impact of inflation that’s more than twice the bank ’s 2.0% target. The governor, who will chair the first meeting of the new Financial Policy Committee on Thursday, also said banks must have "much higher levels " of capital to protect against potential losses.Lenders are continuing to impro ve balance sheets and reduce leverage, King said. A return in interest margins from "unprecedentedly high levels" will affect the speed at which policy ma kers raise interest rates, he said."The committee is watching extremely carefull y for any signs of a pickup in domestically generated inflation and it will take action as soon as it is appropriate to do so," King said. "When conditions in the banking sector return to something closer to normal, those spreads will contract and the rate at which that takes place will have an important influence on the speed at which bank rate will rise."
Some measures of money supply have shrun k even after the bank completed a £200bn bond-purchase program. M4, which t he central bank uses to assess the effectiveness of its asset purchases, fell 2.0% in the 3 months through April on an annualized basis.Data Tuesday showed th e pickup in inflation to 4.5% in May has NOT yet fed through to salaries. Wag e growth including bonuses weakened to 1.8% in the 3 months through April fro m 2.4% in Q1.The challenge for the MPC is weak growth and faster inflation at a time when the economy "is going through a major rebalancing of demand and output," which will take "several years to complete," King said.
A weaker pound was a "necessary precondi tion" for the economy to rebalance, according to King, who said policy makers hav e had to "look through" its effect on inflation. Sterling has dropped about 25% o n a trade-weighted basis since the start of 2007."We could have raised bank rat e significantly so that inflation today would be closer to the target," King said.But that would not have prevented the squeeze on living standards aris ing from higher oil and commodity prices and the measures necessary to reduce o ur twin deficits."
King also raised concern that the Europe an Commission may weaken capital and liquidity rules for banks agreed by globa l regulators under the Basel III accord. He said that putting in place adequa te resolution procedures had to go hand in hand with ensuring that lenders are sufficiently protected against future crises by holding an adequate level o f common equity. "A crucial part of the new Basel III framework is the recognition that only common equity is a truly loss-absorbing layer of capital," he said. "I am, therefore, concerned that the European Commission will propose a weakening of the Basel standards in that area."
King will present the findings of the FPC’s first meeting on June 24th, and said he will comment on where the panel, cr eated to oversee financial stability, sees risks increasing."The FPC will be both doing and learning," King said. In the wake of such a severe crisis, it is unlikely that excessive credit growth will be the major problem over the ne xt few years. Indeed, the present problem is the reverse."Lawmakers at the UK Parliament’s Treasury Select Committee are examining accountability at th e Bank of England and King today responded to comments by former policy makers on the extent of the powers he will have as chairman of the FPC.
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